Colonial to scale back mortgage business
Colonial First State will scale back its participation in the mortgage market after electing to deal with liquidity problems in its mortgage funds by getting out of the business of managing standalone mortgage portfolios.
The group is moving to income funds with more diversified asset structures.
Colonial chief executive Brian Bissaker said the group's "go forward" income product would be its Wholesale Income Fund, a $1.6 billion fund with a mix of local and overseas corporate bonds and mortgages.
Mortgages make up 45 per cent of the assets of the Wholesale Income Fund compared to 80 per cent mortgages in the $850 million Mortgage Income Fund, which Colonial closed last week.
The Mortgage Income Fund has a traditional mortgage trust structure. The unit value is fixed at $1 and provisions or write-offs are charged against the income of the fund.
Last month Colonial reported that provisions in the Mortgage Income Fund had reduced the income available for distribution to a level where the manager would not be able to make a distribution for 18 months.
With the income tap turned off and the possibility that some of the provisions would turn into bad debt losses Colonial decided to wind up the fund. It expects to be able to pay investors out over four years.
Bissaker said the fund manager could make recoveries and restore some of the lost income but even if that were to happen the most equitable course of action was to wind up the fund.
He said: "Do you pay people income and give them their money back and leave the potential losses for those who stay in the fund, or do you give everyone pro rata now?"
Industry commentators have been surprised at the level of provisions in Colonial's mortgage portfolio.
The Mortgage Income Fund and the Wholesale Income fund share a $1.4 billion mortgage portfolio. At the end of January Colonial reported that one per cent of the loans in that portfolio were in arrears and 8.9 per cent in maturity default.
Maturity default means that the loan term has passed but the borrower has been unable to refinance and continues to service the loan with Colonial on a short-term rollover basis. There are nine loans worth $112 million in this category
Mortgage fund managers are renowned for running very conservative mortgage books and seldom report provisions.
The co-head of fund research at Morningstar, Chris Douglas, said: "I would not have expected this to happen to Colonial."
The loan pool has some unusual features. Three per cent of the exposure is to "pre-development land". One loan is worth $69 million, 11 per cent of the portfolio has a loan to valuation ratio of more than 90 per cent and almost 80 per cent of the portfolio has an LVR over 60 per cent.
It doesn't look like the sort of portfolio you would put together so that mum and dad could earn a safe, regular income.
Bissaker defended the prudence of Colonial's mortgage management. "The gearing represents some reduction in the value of the underlying properties. The median LVR is 60 to 70 per cent. I don't think that is high."
Because the mortgage pool is shared by the Mortgage Income Fund and the Wholesale Income Fund the latter fund has also had to make provisions. But because the percentage of mortgages in that fund is lower, at 45 per cent, the effect has not been so pronounced.
Also, the Wholesale Income Fund has a different constitution. Provisions and write-offs are charged against the unit price, not the income.
Bissaker said: "What we see going forward is income funds with variable rather than fixed unit prices and diversified assets.
"We are still looking at the proportion of mortgages we will have in the Wholesale Income Fund."
The Investment and Financial Services Association has recommended that funds with illiquid assets making up more than 20 per cent of their assets should not have redemptions at call.
It is possible that Colonial will reduce the mortgage component of its Wholesale Income Fund to that level.
Bissaker said: "We have not made a determination on that yet. We are still very much in the mortgage game but the level will not be as high as in the past."